There are certain things in life that are tempting, but not necessarily good for your financial or physical health. For instance, chasing returns in the stock market.
You know that you should invest to achieve your objectives. Yet, you are tempted to look at how the markets perform in the short-term, and buy products or stocks that have done well in the recent past. The question is: Can you resist such temptation? It turns out that behavioural psychology can come to your rescue.
One way to stop chasing returns is to flip the question. Instead of asking how much returns an investment offers, ask the question: Will cash flows from the investment meet my consumption requirement?
What difference would this question make? Research in behavioural psychology has shown that individuals behave differently based on the context.
In a study to this effect, researchers found that individuals who were close to retirement reacted differently when they were asked as to whether they would purchase annuity; this is a product offered by insurance companies that typically gives you fixed monthly cash flow for life for a lump-sum amount paid upfront at retirement.
Individuals who were asked to view annuity in a consumption context preferred to buy the product, as it offered stable cash flows for life.
Those who were asked to view annuity in an investment context did not prefer the product, as it offered lower returns compared to a stock-bond portfolio. In other words, when your objective is framed in a consumption context, you tend to seek stable cash flows, not high returns.
This behaviour is called framing bias. It refers to how you react differently based on how the context is framed. During early studies in behavioural psychology, researchers found that patients either refused or accepted to undergo surgery depending on how the doctors framed the likely consequence of the operation. The patients were more likely to reject the surgery if the doctors stated that, say, 10 per cent died during the procedure. But these patients were more likely to undergo the surgery if the doctors stated that the success rate was 90 per cent.
focus on consumption
So, to stop chasing returns you should focus on consumption rather than on investment. As discussed above, you will typically prefer stable cash flow in a consumption context. And short-term returns are hardly stable. The temptation to chase returns could, therefore, gradually wane. Besides, you may prefer stable investments such as bank fixed deposits when your investment horizon is short. And who knows, if you are a retiree, you may just as well prefer annuity.
(The author is the founder of Navera Consulting. Feedback may be sent to knowledge@thehindu.co.in)